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Managing a Young and Growing Small Business

April 30, 2010 by Frank Goley, Business Consultant

A young business is characterized as being a “venture” and entrepreneurial” in nature.  To take a viable venture and make it a growing concern, the entrepreneur must employ effective management strategies.  Without effective management, a young business venture cannot become a successful early stage company no matter how exceptional the entrepreneurial concept, how much funding in its coffers, how exceptional its products/ services or how great the market demand is for them.  It takes effective Strategic Management for a company to become successful and grow.  In this article I will provide some strategies to employ in order to increase your small business’s success, whether it is a fledgling venture or a growing young business.  In my opinion, this is the foundation to successful Strategic Management and should be part of any small business operation, no matter its growth stage.

Market Driven

Ø  By not being completely focused on a defined market, market segments and market niches, a young venture opens the door for competitors to invade its market and take share. 

Ø  Competitive Edge can only be maintained if you understand the trends happening in your market on the customer level.  What many young companies commonly mistake is the concept that a product and service is defined by the customer, not the Company.  Product Development and Marketing should be customer-centric.

Ø  The function of a Marketing Plan is to perform in depth analysis of the market to determine what customers need and want.  A venture may have an idea how to market its products and services but after performing in depth, customer level market analysis, it often finds different markets, different used and requirements then originally envisioned.  A good Marketing Plan has a system to define and examine market segments and niches so an entrepreneur’s “assumptions” can be verified and, most importantly, challenged.

Ø  It is not unusual for a venture to determine that it needs changes to its products and services because its Market Analysis found its assumptions unsustainable or uncompetitive, as well as, identifying other market niches not originally planned for. 

Ø  However, market focus does not stop there.  In fact, it is just beginning because a venture must be continually analyzing market trends and be carefully listening to its customers, so it can anticipate changes in the market in time to adapt and keep its competitive edge.  A new venture should spend a lot of time out in its market place, with its salespeople and customers, to understand future market trends.  This is what good Market Planning and Strategic Marketing accomplishes.

Resource:  For a Step by Step Guide & Workbook on creating an Effective Marketing Plan, please consider my E-book:  The Comprehensive Business Planning Workbook- A Step by Step Guide to Effective Business Planning.

Accurate Financial Forecasting

Ø  For a fast growing, young, small business, inadequate financial focus, analysis, planning and policies are a kiss of death.  Many young companies focus primarily on Profits when they should be concerned with Cash Flow, Capital Management and Budget Control Systems.  Without these three components, profit and loss projections are baseless as over time issues compound within these neglected areas, causing profits to ultimately decline.

Ø  Cash Flow

As I pointed out in my article on Cash Flow Management, sustainable profits come from good Cash Flow Analysis, Cash Flow Budgeting and Forecasting, and Cash Flow Management.

ü  At any point in time a growing company should know 12 months in advance how much cash is required to sustain its Business Plan.  This gives a growth company time to generate cash, as well as, raise the necessary capital to sustain growth and profits. 

ü  A growing venture needs to generate contingency cash in its Cash Flow Budget, along with retaining consistent earnings over time and having credit facilities available to seize market opportunities as they present.

Ø  Capital Management

The well known business guru, Peter Drucker, maintains a new venture outgrows its capital structure in every 40-50% sales increase, necessitating changes to its Capital and Finance Strategy.

ü  As a company projects its Cash Flow Budget forward 12 months, one of the important components of this process is determining how much cash the Company will have on hand at the end of the period, what finance facility is in place to make up the necessary deficit in cash needs and ask the question of whether a different capital facility is necessary to continue.

ü  A Company’s Financial Strategy is intractably linked to its Cash Flow Management and completely necessary to define in order to sustain growth from one period to the next.

Resource:  Please visit my Business Finance Articles for comprehensive information on Capital Planning, Management, Strategies and Acquisition.

Ø  Control Systems

With effective Cash Flow Forecasting, Budgeting and Management in place, along with an established Capital Management Plan, a growing company needs excellent Control Systems in place to manage costs is an important element in Cash Flow Budgeting.  This Control System is also a part of a Company’s Profit Analysis when “controlling” and examining certain expense areas, such as, payables, inventory, production, administration, service and distribution.  Profit Analysis & Cash Flow Analysis should be linked, understanding the relationships between cash generation, profits and expenses.

ü  As a Company grows, it is important the Control Systems grow with it, making changes as needed, just like with the needed changes in the Capital Strategy (as previously discussed).

ü  It is critical to prioritize essential Control areas to the particular business.  Areas to consider and prioritize include Product Quality, Service, Receivables Management, Overhead, Inventory Planning, Production Costs, among others, depending on the type of business.

ü  Control Mechanisms need to be forward-looking as you can’t control past expenses and profit zones.  They can provide valuable clues but more important is focusing on Control features into the future.  As you plan advance Cash Flows, Control Planning should piggy back.

Ø  Market Planning & Strategic Planning

Accurate, realistic Financial Forecasting must come from good processes in Market Analysis, Marketing Strategies and Strategic Planning.

ü  An accurate Market Analysis with good realistic information on the market segments and niches paves the way toward successful, believable and realistic Financial Forecasts.

ü  Good market analysis produces an effective, forward-looking Marketing Strategy, which is implemented through a company’s Strategic Plan.

ü  A Company’s Strategic Plan does many things:

§  Implement Controls

§  Link Marketing information to Financial Forecasts

§  Establish clear Competitive Edge

§  Analyzes Risks & Threats

§  Produces Budgets and Sales Forecasts

In other words, the Strategic Plan is the essential process to effectively produce solid and accurate Cash Flow and Sales Forecasts, including Controls, which result in successful Cash Flow Management and Profitability.  The important point to understand, accurate Financial Forecasting, and all that it encompasses, is a relationship process and speaks to a Company’s Business Plan Development and Implementation Process, System and Structure.

Effective Management Structure & Resources

Ø  It is important to plan well in advance, what management needs to be in place as a company grows and succeeds.  When the company is young and small, it can be managed by a couple people.  However, as the company rapidly grows, it is very important to have a solid management team in place.  Otherwise, all that growth can cause severe problems if not managed effectively.

Ø  As a Business Consultant, when I work with a small company in developing their Business Plan, I put a lot of emphasis on identifying management gaps and analyzing future staffing needs.  In fact, there are two sections of the Business Plan format I recommend which emphasizes this key success factor:  the Company and Management/ Operations sections.  You may have great products and services, along with a well-defined market niche; however, without the right people in place to carry out the Company’s Strategic Plan, then sustained growth, expansion and profitability become impossible to obtain, as well as, maintain.

Ø  It is important to note that Management is a two-prong concern for young companies:

ü  Management Structure:  A company needs a well designed and implemented structure in advance of high growth potential, so a company can properly manage its assets, products, quality assurance, customers, sales people, financial planning, market trends and all the other numerous variables which need attention for sustained growth and profitability.  The Management Structure needs to include both Upper Level Management Planning, as well as, Mid-Level Management.  It is vital there is clear Strategic Direction and Communication Top-Down and Bottom-Up throughout the organization in order to successfully grow and sustain an enterprise’s success.

ü  Management Resources:  Having the right people in a company is the second prong in the Management equation.  Recruiting and retaining the right experience and talent for a Company’s future growth plans and present sustainability is the single most important planning element for a company.  Experience is absolutely vital when a young company is growing rapidly, by leaps and bounds, to ensure the success is not short-lived and to manage the growing assets of the company.  Just as a growing company needs competent Management, it is Management’s responsibility to ensure the Company recruits skilled labor and has effective training programs in place.

Ø  I can’t stress enough, as a Business Consultant and Entrepreneur for more than 20 years, that the Management Equation or Factor for a Company needs to be developed and implemented through its Comprehensive Business Plan.  Without the right people in Management, a company cannot effectively plan and implement Product Development, Quality Assurance and Competitive Analysis; Market Analysis, Research, Planning and Strategy; Strategic Planning and Sales Programs; and Financial Analysis, Modeling, Forecasting and Strategies.  It is a cause and effect relationship, which can quickly implode (or explode) without proper leadership and management.  This is why the first two sections of the Business Plan Format I recommend to clients are the sections on the Company and Management / Operations.  With these two sections planned for and put in place, the subsequent planning and execution of the Market Analysis and Marketing Plan, Strategic & Sales Plan and the Financial Analysis, Forecasting and Strategy can be successfully implemented and subsequent profitability maintained. 

Ø  The most important element for a young growing company to have in place is its Management Structure and Plan.  Well in advance of certain growth milestones, it is important to have the right management team in place with the right mix of experience and skills- what we call Management Resources.  Young Companies may face challenges in recruiting and retaining top management talent and key employees as initial cash flows in the early stages of growth may not support competitive salaries.  To this end, please see my article on Compensation Planning for ways to attract and retain talent without breaking the bank.

Ø  Where does the entrepreneur / founder fit in a growing company with an expanding management team?  The original entrepreneur(s) and founder(s) must analyze where they best fit in a growing, changing company, and how they can best contribute.  This is important to define and plan for in advance, just as Management Planning defines areas of responsibility.  The entrepreneur must learn to delegate responsibilities to his Management Team and learn to be catalyst for the Company’s Strategic Plan.  No more is the entrepreneur the Manager; rather, he is an executive, the CEO, responsible for the overall goals, objectives and growth of the enterprise, leaving the day to day management to his capable Management Team.  It is important that the Company’s Strategic Plan has clear communication channels established between the CEO and top management, who in turn, ensure mid-level managers and their employees carry out the Company’s Strategic & Sales Plan.  This does not mean the entrepreneur should be cut off from his people- just the opposite.  The CEO should frequently spend time with employees at all levels, motivating, encouraging and praising them.  Employees should know the CEO is genuinely concerned about their professional and personal happiness.  Leave the managing to the managers, giving the CEO the important roles of overall Strategic Direction and Employee Satisfaction.

Resources: for more information on Business Management and the CEO:

ü  Small Business Recession Tactics 

ü  Small Business Success & Failure

ü  Leadership Qualities of the CEO 

In my next blog post I will discuss Management Strategies for mature type companies.

Posted in Business Growth Strategies. Comment

Reasons Why Businesses Succeed

April 29, 2010 by Frank Goley, Business Consultant

In my previous blog post I discussed reasons why businesses fail. Wouldn’t it be nice to know why businesses succeed? Let’s get to it…

Characteristics of Successful Business Owners

There are certain qualities successful entrepreneurs share in common.  Some types of people are more suited than others to go into business for themselves, but I am a big believer that one who naturally doesn’t have the typical entrepreneurial characteristics doesn’t necessarily mean he or she won’t be a success.  However, knowing these entrepreneurial commonalities can give you an idea of your propensity to be a successful business owner:

1)     Desire Independence

2)     Strong Sense of Initiative

3)     Motivated to provide for family

4)     Expectation of Quick and Concrete Results

5)     Ready to act and react quickly

6)     Very dedicated to the business

7)     Entered the business as much by chance as design

The Entrepreneur Test

Below are 20 personality traits to gauge your potential as an entrepreneur.  On a scale of 0 to 7, with 7 the highest, rank each personality trait:

1)     Ability to Communicate

2)     Can Motivate Others

3)     Organized

4)     Accepts Responsibility

5)     Can adapt to Change

6)     Decision-Making Capability

7)     Have Energy & Drive

8 )     In Good Health

9)     Good Human Relations Skills

10)  Have Initiative

11)  People Person

12)  Good Judgment

13)  Open-minded

14)  Planning Ability

15)  Persistent

16)  Resourceful

17)  Self-Confident

18)  Self-Starter

19)  Good Listener

20)  Risk Taker

Scale:

110-140         Very Strong

85-109           Strong

55-84             Fair

54 and below  Weak

As an entrepreneur myself, I tend to be on the strong side of these traits.  But not every successful business owner is strong in every one of these areas.  This is why successful entrepreneurs’ recruit those who are strong in the areas they may be weak.  If you are a hard worker and have the drive to be on your own, then over time you can develop and work on improving these useful skills. 

Resource: See my article on CEO Leadership Skills for more details.We have discussed reasons why businesses fail and what are the common traits of successful small business owners. 

Wouldn’t it be nice to know some of the reasons why certain small businesses are successful?  It is important to know what not to do as it minimizes mistakes, but being proactive and knowing what to do can significantly increase your chances of success. 

What Leads to a Successful Small Business?

A Good Business Plan

Going off what I said in the previous blog post about business failure due to inadequate planning, it is absolutely essential to have a good Business Plan and good planning within your business.  What’s the distinction?  You can develop a good business plan, but if you don’t implement it and make it a part of the fabric of your business, then its usefulness is minimal.  However, to develop an effective Plan, you need to have a good business planning system to employ, and it is often very helpful to work with an experienced Business Consultant in its design, development and implementation. 

Resource: For a Comprehensive Business Planning Process, please consider my Business Planning Guide and Workbook.

An Adequate, Well Defined Market

Market Research is critical as it gives your planning a dimension of predictable results.  It links your Product Development with your Strategic Plan. 

Resources: For more information on developing an Effective Marketing Plan, please see my article on Market Analysis & Planning. For comprehensive Market Development advice, see my article on Small Business Marketing Strategies.

Understand Industry and Market Trends

Understanding both where your industry and market are heading is important to staying competitive and continuing to meet your customer’s needs.  Never assume you have captured your market and can sit on your laurels.  Install Marketing Systems in your business to continually analyze and predict customer and market behaviors and needs.  Having consistent contact with your customers can help you produce better products, offer better suited services and grow along with your trending market. 

Obtaining and Using Accurate Information

Accuracy in planning market trends and business growth must be reliant on information that is accurate and realistic.  Then taking that accurate information and applying it to your present and future business capabilities is an important process.  You must be realistic as to whether you can effectively exploit the potential of the information with your given human, operational and financial resources.

A Good Capital Acquisition Strategy

It is important to come into a business with a strong equity position.  You can then leverage off that cash strength with competitive, appropriate financing.  A cohesive Financial Strategy, and implementation of it, is vitally important to a business’s success.  A business needs not just adequate capital, but the right type of capital for the business, its goals and objectives. 

Resource: Please refer to my Business Finance Articles for more assistance in developing and implementing a Successful Financial Strategy for your business.

Effective Recruiting and Strong Human Resources

Going into business with the right people and subsequently recruiting and retaining good people is vital for a business’s success.  Often a talented, experienced, highly-skilled employee will save you money in the long run and be very effective in a crisis; as compared to, scrimping on your labor costs, having to constantly train new people, relying on more people to get the job done and experiencing high-turnover and low employee morale. 

Resources: Please see my articles on Small Business Recession Tactics and Compensation Planning for more help on hiring and retaining the right talent for your Company.

Expertise and Experience

From the Company’s Founders and Principals to the employees in the field, a high level of experience and expertise is necessary to effectively compete in today’s markets.  The most successful entrepreneurs, bar none, are those that surround themselves not just with talent, expertise and experience, but have people on their team which fill the gaps in their personal experience base.  We are only as smart and talented as those we surround ourselves with.  Know your limitations and have the right people on board to fill the gaps. 

Understanding the Implications of Government Regulation in your Business, Market and Industry

Being surprised by changing regulations is not good.  Keep yourself well educated on Government Regulatory Trends through good government relations and active membership in Industry and Business Associations.  The efficacy of your product, service or market can change 360 degrees on the whims of government.  So be involved and cognizant of this significant element.

Effective Time Management

A small business owner is pulled multiple directions at the same time all day long, every day.  Your ability to multi-task is important, however, putting systems in place to effectively balance tasks and time is just as important.  Delegation and planning are essential in effective time management.  As pointed out previously, you must have good people around you to delegate responsibility, as well as, to assist you in managing your time as effectively as possible.  Effective Time Management is a function of good planning as one comes with the other. 

Hard Working for Long Hours

Last but certainly not least, Successful Business Owners must be willing to work very hard and spend many long days and weeks getting the job done for their customers.  The Entrepreneur is often the first one to arrive early in the day and the one who leaves late in the day or night.  Having a good Business Plan helps the successful business owner to work “smart”, but there is no way around good old fashioned hard work, particularly in the early stages of a company’s growth.  You must be willing to put in the long hours to reap the benefits of self employment.

Concluding Advice

If you are contemplating starting a new business, do something you really love to do and have a passion for.  The work is hard so you might as well enjoy it.  Providing a great product or service to your customers is a worthwhile experience and should be something you really believe in.  Passion is what carries you through the inevitable rough patches, no matter how well you plan and set up your Company.  Small Business is simple:  see a need and fill it.  Working hard will be replaced with working smart as you build your Company over the years, gaining invaluable firsthand knowledge.  You will find, though, as your Company matures, the real thrill for an Entrepreneur is the start-up phase, when you build something from scratch and do it successfully.  Good luck in your endeavors.

Posted in Business Growth Strategies. Comment

Why so Many Businesses Fail

April 28, 2010 by Frank Goley, Business Consultant

Having been a entrepreneur, small business owner and consultant for twenty plus years, I had the opportunity to learn from my own mistakes, as well as, seeing the business failings of others.  I have learned that there are definitely reasons why a small business fails; why some are successful; and why certain types of people are more successful business owners and entrepreneurs.  The good news is most successful small business owners had many failings before achieving a level of success, and the object of this article is to identify their (and my) mistakes.

Lack of Capital

When starting a business, an entrepreneur needs to first bring sufficient cash to the venture.  I recommend a minimum 10% of the total funding amount to come from Owner’s Equity, with 20% being optimum.  Having a strong equity stake in the beginning of a Company’s life makes acquiring the additional capital much easier and less expensive.

Strong Owner’s Equity shouldn’t stop after a Company’s start up stage.  A Company’s strength in Retained Earnings is key to growing the Company, seizing on market opportunities and obtaining future finance.  If you lack owner’s equity capital, there is additional undue pressure on a Company’s cash flows, making it increasingly hard to obtain the appropriate funding.  For more information on Successful Business Funding Strategies, please see my Business Finance Articles.

Lack of Business Knowledge

Successful entrepreneurs are typically well read.  They are always striving for more knowledge and take advantage of the wealth of resources offered through business schools and, as importantly, read other successful entrepreneur’s books. A Business Degree or MBA is a helpful foundation but gaining knowledge from those who have found success is critically important to understanding why businesses fail, as well as, spawning new ideas and markets.

Inexperience

Inexperience ties in with Lack of Business Knowledge.  Business Knowledge can be acquired in school, through books and magazines, and via experienced business owners.  Business Experience is the critical and common link between successful entrepreneurs.  Inexperience costs money when mistakes are made. Make too many mistakes, and you are out of business.  Mistakes are a natural part of the business learning curve, however, minimizing them is very important to stay in business.  I highly recommend going into a business which you have experience and passion while seeking out those who have been in the same business for a time and reached a significant level of success.  Experience comes with time, but you can also learn from the mistakes others have made before you.  Cultivate business relationships, mentoring opportunities and networking events and forums.  I can’t tell you how many times spending time with an experienced entrepreneur has paid off in spades, in my business life in so much as, what not to do, as what to do.

Poor Management

This is a biggie.  If you can’t effectively manage people, learn how to and / or hire someone who can.  Some entrepreneurs are great at this vital skill and others don’t have the patience for it.  However, the bottom line is you can have a great idea, product and market, but poor management will cause business failure 9 times out of 10.  Poor management often evolves into poor employee morale and high employee turn-over, which significantly hampers a company’s ability to compete in the market.  Management doesn’t just entail employee management but also the ability to manage the Company.  Having a good Business Plan, excellent Profit Strategies, and effective Cash Flow Management are just some of the important management tools necessary to run a successful business.  Businesses often fail because they haven’t owned up to and analyzed their weaknesses, which often stems from poor management practices.

Inadequate Planning

The lack of a business plan or the poor implementation of a plan is typically the number one reason for business failure.  So why do small businesses neglect to plan?  Because it can be a very difficult process to do well; day to day business activities leave them little time to plan; they fear the weaknesses and problems’ planning reveals; they lack the knowledge on how to effectively plan; or they feel the future can’t be planned for. 

However, to be successful in a small business by relying solely on luck is a huge gamble and often meets failure.  You must know where you are going and how to get there.  A good Business Plan guides the entrepreneur on how to operate a business; interest investors and bankers on financing the business; provide direction and motivation to employees; and establish an environment which will attract and retain customers and talented employees.

I have seen many instances where a business has a business plan, but it lacks the operational and control features to successfully implement it and the strategic know-how to successfully link the marketing plan with effective financial modeling and forecasting.  Good planning is both Strategic, which is high-level, long range goal setting and meeting of objectives, and Operational, which implements the Strategic Plan, operates the business and sets the policies, methods and procedures to do so.

Planning actually means good business management.  Inadequate planning often translates into poor management functions.  It is a process which relates and inter-relates closely to Managerial Functions. Many business Owners don’t understand the extent of these vital relationships, thereby producing inadequate plans, which ultimately lead to business failure.

Understanding the components of the Planning Process makes it much easier to develop and implement a good Plan:

Ø  Planning:

ü  Organizational Objectives

ü  Establishing Programs, Policies and Strategies to achieve the Objectives

Ø  Organizing:

ü  What Resources and Actions are needed to meet Organizational Objectives

ü  Setting up Working Groups

ü  Assigning authority and responsibility

Ø  Staffing:

ü  Select, train, develop, place and orient employees

ü  Foster employee productivity

Ø  Leading:

ü  Effective Communication and Motivation

ü  Performance

ü  Goal Achievement

ü  Work Assignments and Direction

Ø  Controlling:

ü  Setting Standards

ü  Measuring Performance

ü  Corrective Action

The underlying reason why a small business fails often stems from poor Operational Planning.  Operational Planning is critical, since it helps business owners and entrepreneurs avoid costly mistakes, saves considerable time over the long term, and successfully bridges the gap between planning on paper and implementing the plan.  Three types of Planning, or Phases of planning, significantly improve a small business’s chance to achieve success:

Ø  Pre-Start Up Operational Business Planning

Ø  Ancillary Business Plans customized for Investors, Commercial Finance, Customers, Key Employees, Suppliers and the such

Ø  Post-Start Up and Growth Continuous Planning and Control

The point I am trying to drive home here is that inadequate Planning stems from the fact that most small business owners fail to fully understand all of Planning’s parts, and how to effectively harness and implement those parts into cohesive Operational and Strategic Plans, Goals and Objectives.

For more resources in this area and a detailed, step by step business planning process, please consider my book: The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning.

Posted in Business Growth Strategies. Comment

Applying Business Profit Analysis and Planning Principles

April 27, 2010 by Frank Goley, Business Consultant

Overview

In my previous blog posts, I have discussed in detail the Fundamentals of the Income Statement and How to Analyze an Income Statement to Maximize Profits, along with a step by step process on how to Plan for Profits.  To conclude and pull this all together, I will give some examples of how good Profit Analysis and Planning made for success and the flip side of that scenario (and the reasons why the companies were unprofitable).  I will present three scenarios of Manufacturing Companies which had good profitability, mediocre profitability and one which failed.  All three companies are in the same industry.

Successful Company:  Company A

In examining Company A’s Income Statement, there are many clues as to why it was a successful company:

– Market:  Established a market by determining a market need and effectively filling that need. In a five year period sales grew from $11K to $60M in relation to a market that grew from $413M to $510M.

– Expenses:  Expenses were reduced as a percentage of sales over the years, with Engineering and Sales Expenses at year 5 three percentage points below the industry average. The lower engineering costs were attributable to high caliber engineers who designed a superior product which required fewer development changes and allowed employees to concentrate on innovation in the subsequent years.

– Marketing Costs were low due to using a network of Distributors to sell the products rather than using a large sales force and manufacturing reps. The small sales force was used to concentrate on high volume accounts, giving the company a big return for its investment in its sales people.  This alone added 7 percentage points to its bottom-line profits.

– Cost of Sales was maintained at 62% of sales during the 4^th and 5^th years of operation which provided a 38% Gross Margin.  This GM is about 10% above the average Break Even Point for similar companies, giving Company A a good cushion of profitability.

Mediocre Company:  Company B

Company B was a six year old company and located in a region of the country that offered lower labor and overhead costs.

– Sales Success: Company B had very aggressive pricing strategies and undercut its Competitors to achieve large volume orders. Profit was not the motive; dominance was the underlying strategy.

– Aggressive Pricing:  In relation to its closest competitor, Company B’s sales were three times larger, material costs 15 percent lower and labor 5 percent lower.

– Overhead:  This is where Company B made its mistake.  Overhead expenses were 27%, causing Cost of Sales to increase to 76%, leaving a Gross Margin of only 24%, which was Break-Even in the best of circumstances when accounting for Engineering, Marketing and G&A.  This was a ripple effect which greatly reduced Company B’s profitability, causing the parent company to sell it.  An acquiring company quickly corrected the Overhead issue and installed a new General Manager to institute better profitability controls, which helped it recover over time. 

Company Failure:  Company C

Company C captured 27% of its market, yet failed to stay profitable.

– Management:  Plagued by severe management problems.

– Spending:  Flamboyant and expensive habits.

– Product:  Poor Design and low manufacturing quality.

– Staff Reduction:  As a result of poor management, financial losses and product failures, Company C reduced its staff of 600 to 400 employees.  The Company subsequently fixed its design issues, increased its market share from a significantly lower share of 2% to 4% and grew employment to 150 employees.  The Company was climbing back and barely keeping its head above water.

– Turnover: Company C experienced severe top-management problems, and as a result, lower-management, along with the technical and production ranks, suffered from excessive employee turnover.  In a year period, employee turnover was over 100%. Company C as a result experienced a bad reputation in the Region’s labor pool causing it major difficulties in attracting quality employees. As a result of its low quality labor force, Company C’s product quality declined and customers were lost. The high employee turn-over created a situation that made it impossible to reduce product costs. Company C was constantly in the training mode and the domino effect of catastrophic events forced it to cease operations.

– The Numbers:  COGS amounted to 84%, leaving only 16% for Engineering, Marketing, G&A and Profit.  This is clearly out of whack by 20%.  Material Costs totaling 53% could not be reduced due to high employee turn-over, which created a loss of purchasing continuity and poor procurement strategies.  Slow payments to Suppliers contributed to higher material costs since the suppliers increased their prices to compensate for the added costs of doing business with Company C. Company C strove to make improvements, but the improvements were made in the wrong places. Labor Costs were reduced from 8% to 4% and overhead from 10% to 5%, using the same products and predicting inflation rate of 13%. G&A at 3% was reduced dangerously low. The combination of indiscriminate cutting of costs, poor labor quality, poor product quality and very expensive material costs ultimately combined to doom Company C.

What can be Learned?

By applying Profit principles I have previously discussed (namely, Income Statement Fundamentals, Profit Analysis and Profit Planning), I showed companies successfully and unsuccessfully applied these profit principles.  The Income Statement is a good place to start your Profit Analysis as it shows how a company has spent its money in years past and what it projects its spending to be in the future, along with whether the proportions of its revenue streams and expense / cost levels were healthy or unrealistic.By understanding what an Income Statement is telling you, how to properly Analyze it for maximum Profits and how to successfully and realistically plan for Future profits, you can significantly increase and sustain better Cash Flows.  However, the process should not stop here.  As you have planned to Maximize Business Profits and implemented it successfully through your company’s Strategic Plan,   Cash Flow Management becomes the next step in the Profitability process.

Posted in Business Financials. Comment

Profit Planning

April 26, 2010 by Frank Goley, Business Consultant

A lack of accurate Cost Estimation and Analysis results in Profits of unknown quantity and often Loss.  Some Companies who are profitable still fail.  Why?  Profits are not necessarily in the form of cash, such as Accounts Receivable, which may presently be uncollectable.  Focusing just on Net Income can be a mistake unless contingent variables are considered.  It is vital that a Company sets and monitors certain Benchmarks in its Strategic Planning from which performance can be measured and tracked.

Profit Relationships and Components

Net Income (Profit) = Revenue (Income) minus Expenses (Costs)

a.     Revenue comes in the form of Cash and Accounts Receivable.

b.    There are Two Types of Expenses:  Fixed and Variable             

 i.        Fixed Expenses:  incur periodically, regardless of operational effect and include items such as Rent, Insurance and Depreciation.            

ii.        Variable Expenses:  Vary according to the level of Operations.  This includes items such as Product Labor and Material, Sales Promotion and Cost of Delivery.

c.     Profit Expressions:             

i.        Gross Income = Net Sales minus Cost of Goods Sold (COGS)            

ii.        Operating Profit = Gross Margin           

iii.        Net Income Before Tax           

iv.        Net Income After Tax            

v.        All of the above expressions of Profitability indicate a certain relationship between Revenue and Expenses.  A decline in Profit Margin should be the catalyst to search for a cause, such as an increase in expenses; discounting or pricing errors caused a decline in per unit sales revenue; or a change in business operations.

Plan for Profit

Important Fundamentals:

a.     Liquidity provides maximum flexibility.

b.    Income Statement is viewed in relation to the Balance Sheet and the Cash Flow Statement.

c.     Managed, under control Growth leads to Planned Growth.

d.    Short and Long Range Business Planning which has clearly integrated relationships between Product Development, Market Planning, Strategic Planning and Financial Management.

Profit Planning Steps:

a.     Step 1:  Profit Goal             

i.        A target value based on the realistic, developed results of your Company’s Strategic Plan.

b.    Step 2:  Planned Sales Volume required to make the Profit Goal.             

i.        Utilize Operating and Sales Budget Forecasts            

ii.        The Forecasts influence decisions on Materials Purchasing, Production Schedules, Financial Resource Acquisition, Plant and Equipment Procurement, Personnel Enumeration, along with Employment and Inventory Planning.           

iii.        Forecasts derived from well developed, realistic determinations of Market Conditions, Market Trends, Industry Trends, Competitive Analysis, Competitive Edge, Market Segmentation, Promotion Strategies, Pricing Strategies, Distribution, Inflation and so forth.           

iv.        Sales Volume Forecasts which are achievable and accurate come from the previously prescribed development relationships between:

a)     Product Development

b)    Market Planning

c)     Strategic Planning            

v.        Picking arbitrary numbers for steps 1 and 2 will result in faulty Sales Forecasts, tainting the process from the beginning.

c.     Step 3:  Expenses Estimation for the Planned Sales Volume             

i.        Use previous years’ numbers if an existing company. For start-ups, analyze similar companies in the industry and tap published research to come up with realistic estimates of Expenses.            

ii.        Adjust Expense Projections based on:a)     Change in Economic Conditionsb)    Ratio of Expenses to Sales Level Changec)     Production Methods Improvements and Efficienciesd)    Reasonable salary levelse)     Materials to produce your goodsf)     Labor to produce your products           

iii.        Establish a Cost of Goods and compare it to the industry average for accuracy.           

iv.        Figure in expenses which vary directly with changes in Volume.

d.    Step 4:  Estimated Profit 

i.        Estimated / Projected Sales Income minus Expected Expenses.    

e.     Step 5:  Compare your Estimated Profit with your Profit Goal (step 1)

   i.        If there is a wide discrepancy between estimated profits and your profit goal, continue with the subsequent steps.

f.     Step 6:  Determine Alternatives to Improve Profits             

i.        Change Planned Sales Income:

a)     Increase Sales Promotion

b)    Improve Product Quality

c)     Improve Access to Product’s Availability

d)    Alternative Product Uses

e)     Analyze Unit Pricing Strategy to determine Best Pricing Policy for your defined Target Markets

f)     Better Service

g)    More Product Reliability

h)     More Integrity in your Sales Process

i)      Better Updating / Upgrading Strategy

j)      Better After-Market Sales Strategy             

 ii.        Decrease Planned Expenses:

a)     Better Control Systems for Product Development

b)    Minimize Losses

c)     Increased Productivity of People & Machines

d)    Product Re-Design, Re-Branding, Re-Packaging

e)     Product Improvements

f)     Cost Reduction Analysis and the resulting integrated strategy

g)    Better Budgeting Control Mechanisms           

 iii.        Reduce Unit Costs:

a)     Add other products in the mix to offset costs

b)    Using idle capacity and assets innovatively

c)     Make certain parts internally if more efficient than purchasing from Vendors

d)    Kaizen Costing:  Advance Cost Targets in all aspects of Product Design, Development and Production.  Each Company Department and Cost Center sets specific Cost Reduction Plans for each quarter.           

iv.        Subcontract Certain Work and Outsource

g.    Step 7:  Determine how Expenses vary with Sales Volume Changes             

 i.        Experiment with Expense levels in selling fewer or more units with the information obtained in Step 3, understanding the relationship of Fixed and Variable Expenses to find the optimal mix of Products and the Unit Sales of those Products.           

 ii.        Beware:

a)     Analyze Limited changes in Sales Volume as High Sales Volumes are costly and expend a lot of effort and Low Sales Volumes results in extra costs due to idle capacity, lack of volume discounts, underutilized highly trained and expensive labor force, and so on.

b)    Changing conditions:  Economic shifts, Inflation, Deflation, Customer Shifts, Competitive Products, Market Shifts and other Factors causing changes in Unit Costs.

h.     Step 8:  Understand how Profits vary with Sales Volume Changes             

i.        Use different Sales Volumes to determine the resulting Break Even Point and the Profitability Vector.

i.      Step 9:  Analyze Profit Alternatives             

i.        Using the information generated in Steps 6, 7 and 8 consider profit increasing alternatives, such as:

a)     Sales Price Changes

b)    Change Advertising / Promotion Strategy

c)     Reduce Variable Costs

d)    Increase / Decrease Quality of Products

e)     Find the right mix of Products

f)     Eliminate Low-Margin Products

g)    Bundle High Margin Spare Parts with New Equipment

j.      Step 10:  Finalize the Strategic Plan and Implement              

 i.        Measure the Strategic Plan’s implementation over time to keep track of your Company’s resulting Pre-Tax Return on Equity and Pre-Tax Profit Margin.            

ii.        Implement Tax Savings Strategies to retain more Earnings for future Opportunities and Expansion. 

In my next post, I will discuss how to apply the Profit Analysis and Planning Process.

Posted in Business Financials. Comment

Maximizing Profits in your Business – Profit Fundamentals and Analysis

April 23, 2010 by Frank Goley, Business Consultant

This post will show the business owner how to understand and analyze an Income and Expense Statement and perform Profit Analysis. Having a good Business Plan in place to successfully run your business is important but implementation of that Plan is necessary to reap its benefits. One aspect of implementing your Business Plan into your Company’s Operations is through good Income Statement Analysis, Planning and Application.  As your Strategic Plan tracks and implements your Profitable Operations, it is important to understand what your Income Statement is telling you, how to realistically project your future profit potential and how to effectively maximize Company Profits. 

I.        Income Statement Fundamentals 

Let’s first understand what is in an Income Statement and what the various components of it represent.  Note:  I am using a Manufacturing Company as an example. 

A.    Major Components of an Income Statement: 

1.     Sales and Revenue

2.     Cost of Goods Sold / Cost of Sales (COGS)

a.     Material

b.    Direct Labor

c.     Manufacturing or Factory Overhead

3.     Operating or Gross Margin (GM)

4.     Expenses

a.     Engineering

b.    Marketing

c.     General and Administrative (G & A)

5.     Pre-Tax Profit

B.    Revenue / Sales:

1.     Breakdown of all Products and Services and the resulting Revenue for each category. 

2.     Last Line should be the overall average:  Units sold times the Average Unit Price.

C.    Cost of Goods Sold / Cost of Sales:

1.     Cost of providing a product or service for sale.

2.     In a manufacturing company it comprises of:

a.     Material:  Raw material and parts required to build a unit.  A significant part of each Revenue Dollar, i.e.  40% of each sales dollar on new equipment and 15% for spare parts. 

b.    Direct Labor:  Labor cost in manufacturing a product.  Typically, 7 cents of each Revenue Dollar for new equipment and 1.5 cents for spare parts. Note: Material and Direct Labor costs are Variable, varying directly to the quantity produced. 

c.     Manufacturing or Factory Overhead:  Costs which don’t contribute directly to the production but necessary to build a product.  For example, Employees of the Purchasing Department, Material and Production Control Planners, Clerks, Quality Assurance Inspectors, Manufacturing Department Personnel, etc. Note:  Overhead is a Fixed Expense, not fluctuating appreciably with output. 

D.    Operating Margin: 

Sales minus Cost of Goods Sold

E.    Expenses:

1.     Engineering

2.     Marketing:  Usually the highest expense.

3.     General & Administrative:  Usually the smallest expense.

F.    Pre-Tax Profit: 

Operating (Gross) Margin minus Expenses 

II.        Maximizing Profit Analysis

A.    Market Analysis and Marketing Plan:

1.     Must have an accurate Analysis to determine what the Market is willing to pay. 

2.     Understand clearly your Competitor’s pricing and develop a successful Pricing Strategy for your Marketing Plan. 

3.     Price War Considerations: 

a.     Pricing below your Competitor’s pricing may go too far and set off a Price War. 

b.    Competitors respond by reducing prices below market values to recapture market share lost. 

c.     Customers can become accustomed to the lower fair-value price, making it hard to return to pre-war pricing.  Gross Margins of a profitable 50% can quickly erode to the breakeven point, typically about 30%. 

d.    An Accurate Market Analysis and an effectively implemented Marketing Plan understands both the Customers and Competitors responses to certain price levels. 

B.    After Market Sales:  Spare Parts 

1.     Most profitable product line:  70% Gross Margin (GM), representing about 12% of Sales Revenue. 

2.     Cost of Goods (COGS) on Spare Parts is normally about 30 cents of each Sales Dollar when operating with a 70% Gross Margin. 

a.     COGS on new equipment represent about 60 cents of each Sales Dollar and a resulting 40% GM. 

3.     Key:  Keep a high ratio of spare parts to new equipment for Maximum Profits. 

a.     Package Spare Parts when you sell New Equipment with a GM range of 70-95% on the various parts, discounting the New Equipment. 

C.    Cost of Materials: 

1.     Although Materials (all the parts, components and sub-assemblies of a product) is a cost that is fixed on a per unit basis, it can be manipulated for maximum profit potential. 

a.     Material for a manufacturing company typically represents about 38 cents of each sales dollar for new equipment and about 1.5 cents per sales dollar for spare parts, for a total average of about 39.5 cents per sales dollar. 

2.     Value Engineering:  Designing and re-designing products for the lowest cost without performance compromises. 

a.     Each part and sub-assembly is analyzed to determine if comparable function can be achieved at lower costs by utilizing different materials, components, manufacturing processes or lower cost vendors.

i.        An example would be adjusting a component’s tolerance from 5% to 10%, provided the design analysis finds the substitution acceptable.    

 ii.      Simply cleaning a part during the machining or assembly steps can lower costs. b.    Examine production procedures to reduce waste and spoilage. 

3.     Raw Material Management:  Strongly contingent on good Market Planning & Forecasting.  If the forecast is too optimistic, then too much material is purchased, which unnecessarily raises inventory costs.  If the forecast is too conservative or too low, then too little material is procured, which can result in late product delivery, customer dissatisfaction and lost sales, which in turn causes an increase in effective material costs. 

4.     Inventory Management: 

a.     Minimize costs through volume purchase agreements with suppliers.                       

 i.        Contract with a supplier to buy a maximum number of parts over a fixed period, normally 1-2 years.         

 ii.        The buyer stipulates minimum and maximum monthly quantity limits in its purchase order, which allows the buyer to adjust inventory levels within the set range and to known production requirements at the time.          

iii.        Again this system only works well when the Marketing Forecast is accurate within reasonable levels.                          

  iv.        This also helps suppliers as they can optimally adjust their inventory and labor levels, which enables them to pass savings on to the buyer as discounts.                                           

v.        Bill-Back Clause Protections for the supplier:  Protects the supplier if the Buyer doesn’t meet the minimum purchase level and/ or puts a premium or extra discount on purchases exceeding the maximum agreed level. b.    Use an integrated Computer Software Program, customized to your Company which tracks, manages, budgets and forecasts your Raw Material and Inventory needs.  This system needs to be carefully integrated with your Marketing Department. 

5.     Good Relationship with Suppliers: 

a.     Suppliers experiencing low capacity offer better discounts.

b.    Suppliers can suggest different methods, processes, materials or manufacturing tolerances to help you save money. 

c.     Pay your bills early or on time to receive Supplier incentive discounts.  Late payments will result in higher cots being levied in the future. 

d.    Have excellent communication lines established with your Suppliers which can be very helpful when you hit a downturn in sales and find meeting obligations difficult. 

e.     Develop a Supplier Business Plan. 

D.    Direct Labor Cost Savings Strategies 

1.     Direct Labor on average for a manufacturing company should cost about 9 cents of each sales dollar; of this cost, new equipment is 7 cents and spare parts is 2 cents. 

2.     Keep personnel turnover low, which reduces training costs. 

a.     Skilled, trained labor can accomplish the same task at a lower cost, with fewer errors, along with, better efficiency & productivity. 

b.    Proactive Employee Incentives is much more effective than trying to retain employees through fear tactics. 

c.     Provide good working conditions and don’t overwork your experienced employees.  Use temporary or flex workers for short-term production gear ups and upturns. 

3.     Locate production facilities in less expensive parts of the region which offer tax incentives and lower labor costs for highly skilled laborers. 

E.    Manufacturing Overhead Cost Savings 

1.     The key in this area is Management Control.  Overhead typically accounts for about 14 cents per sales dollar. 

2.     Good Control Mechanisms executed from the outset can keep costs in check without Budget cutting. 

3.     Overhead Cost Management is divided into three areas: 

a.     Facilities, Communications & Data Management 

b.    Indirect Labor 

c.     Operating Expenses 

4.     Facilities:  Immediate space requirements should have expansion options which meet your Company’s Strategic Plan Goals. 

a.     Ensure your Facility is designed to minimize utility costs and located in an area which has reasonable utility rates. 

5.     Communications:  Bundle your communication needs into a package for maximum cost minimization, better company integration and superior operating results. 

a.     Bundle your communications with a Company that offers excellent customer service as that keeps expensive down-time to a minimum. 

b.    Bundle a maintenance contract with your Communications package to minimize long-term costs. 

6.     Data Management:  Utilize a Consulting Firm to customize a Data Management system to your Company’s products and operations.  This should be carefully linked to the Marketing and Strategic Planning Departments, while also fully integrated into the Company’s procurement, inventory, sales and operations areas. 

7.     Indirect Labor:  Typically the second largest expense of operations departments in manufacturing companies.  This is an area where maximum Control can be utilized. a.     Weigh the costs of trained labor verses inexpensive labor and determine a cost effective, yet productive mix of the two. b.    Utilize strict employment level management.  Indiscriminate hiring and firing has detrimental long-term effects. c.     Foster strong Employee communications, mutual trust and relations, which ensures efficiencies and lower overall labor costs.  

8.     Operating Expenses:  The least expensive operational category for a manufacturing concern. 

a.     The key here is avoiding waste. 

b.    Satisfied employees, who understand how waste negatively affects their pay and benefits through lower productivity and higher per unit costs, will reciprocate in adhering to Waste Management Procedures. 

F.    Cost of Goods Sold (COGS) 

1.     Understand that COGS is the sum of Materials, Labor and Overhead.  COGS can amount up to 61% of each sales dollar, so just 1% saved here can make a significant impact on Pre-Tax Profits. 

G.    Gross Margin (GM) 

1.     The difference between Sales and COGS.  For a Manufacturing Company, a good target goal is 50% GM, as break-even is often in the 25-30% range.  While 50% GM can be a difficult goal, ensure you have at least a 10% cushion between GM and Break-Even to ensure profitable operations during slow periods or unpredictable circumstances. 

2.     How do you maximize GM? 

a.     Effectively managing your Company’s Engineering Costs and G&A expenses. 

b.    Realistic and integrated Market Planning. 

c.     Any costs minimized in Engineering, Marketing and G&A adds significantly and directly to Pre-Tax Profits. 

3.     Manage Engineering Costs: 

a.     Consider Engineering as an Investment and should be integrated closely with your Company’s Strategic Plan.  The most expensive cost initially, stabilizing to @ 9 cents per sales dollar. 

b.    Accurate Statement of Work:  Engineering Manager divides each project/ product into components of skill, time, skill hours, labor requirements, labor costs, benefits costs, supply costs, material costs and so forth. 

c.     You cannot manage costs until they are broken down, identified and quantified. 

d.    Engineering Cost Management should be closely aligned with the Strategic Planning Department’s Budgeting Process and Controls in order to fully maximize cost reductions in this area. 

4.     Marketing Expenses:  Generally the highest of the three Expense Categories for Manufacturing Companies.  10 cents per sales dollar is typical for a stabilized Manufacturing Company. 

a.     Areas to Analyze:  Salaries and commissions of sales people; manufacturing reps commissions; product managers salaries; service and administrative personnel salaries; advertising and travel costs; communication costs; supply costs. 

b.    Understand how Bonuses and Incentives can significantly increase the productivity value of your Marketing Expense bottom line. 

5.     General and  Administrative Expenses (G&A):  Typically the least expensive expense category for a manufacturing company.  7 cents of each sales dollar is a good goal. 

a.     Components Include:  CEO, Executives, Finance, Accounting, Personnel and Support Staff. 

b.    Primary expense item in this category are salaries, so Competitive Salary Structures should be monitored regularly to ensure the 7% goal is maintained. 

6.     Total Expenses:  For a manufacturing company, total Expenses normally account for 25 cents of each sales dollar.  The remainder is Pre-Tax Profit, which should typically be in the 15% range or 15 cents per sales dollar. 

H.    Pre-Tax Profit: 

Pre-Tax Profits can only be effectively maximized through a step by step Analysis of a Company’s Income Statement, ensuring it is closely aligned with a Company’s Income Statement, ensuring it is closely aligned with a Company’s Marketing Analysis, Marketing Plan and Strategic Planning.  The resulting strategy will significantly minimize Expenses, which has a direct effect on Pre-Tax Profits.  This should be a comprehensive, cumulative approach in order to achieve maximum Profitability. 

I.      After-Tax Profits: 

In a 30% tax bracket, after-tax profit is 10.5% or 10.5 cents per sales dollar. 

1.     Higher or lower resulting tax brackets can significantly affect After-Tax Profits, so utilizing an Accounting and Tax Firm specializing in your business is highly important. 

2.     Average after-tax profit for Manufacturing Companies runs about 5%. 

3.     After-Tax Profits are vital to a Company’s Growth and Investment, resulting in more Retained Earnings and higher Cash Flows and needed when opportunities arise in the market. 

4.     Cash Accumulation allows for better leverage and terms when negotiating funding to expand and grow your Company. 

J.     Summation of Components: 

The Income Statement Analysis illustrates how sales dollars are distributed and how to minimize costs in order to maximize profits.  Central to this step by step, cumulative Analysis is to determine how each Income Statement Component’s percentage of cost contributes to the Sum Total, as adjusting each component has an exponential effect on Profitability. Profits can only be maximized by clearly understanding and managing its parts.

Having discussed the Fundamentals of the Income Statement and performed a Profit Analysis, in my next post I will explain how to effectively Plan for Profits.

Posted in Business Financials. Comment

Managing Cash Flow in your Business

April 22, 2010 by Frank Goley, Business Consultant

The Cash Flow Statement is derived from the Cash Flow Budget, which is a forecast of cash receipts and payments.  The Cash Flow Budget shows if enough cash is available for expenses, equipment and goods purchases.  Cash Flow also indicates whether external sources of cash are necessary.  While many business owners think profits are the most important financial component of a company, the lack of cash is often the biggest reason for business failure.  In fact, a business may be profitable; yet, it doesn’t have the cash to pay its expenses.  Therefore, effective Cash Flow Forecasting, Planning and Management are essential to a Company’s success.

Cash Flow Planning is short-term (daily/weekly), as well as, long-term (monthly/quarterly/yearly) so a business has the optimum amount of cash on hand when required.  The Cash Flow Budget controls the flow of cash into your business to make necessary payments, while not maintaining an excessively high Cash Balance.  It is a function of Management because the efficiency, speed and effectiveness of moving cash through a business enables the business owner to turn it over into sales and income more quickly, resulting in greater profitability and minimized interest payments.

The Cash Flow Statement can be a complicated Financial to develop and manage.  Therefore, the Cash Flow Budget is a great place to start and is a very effective tool to manage your business cash flow.  The Cash Flow Budget has three principal sections to manage:

1)     Cash to be received

2)     Expected Cash Payments

3)     When payments are to be made

The monthly Cash Flow Budget is the primary Cash Flow format.  We recommend working on three months at a time and build out the Budget for 12-18 months projected in advance.  Each month should have a Budget Goal and Actual Column, and the Budget should be on a rolling basis (as you complete a quarter, budget another three months).

The first bottom-line for the Cash Flow Budget is the End of the Month Cash Balance, which is computed as follows: 

Beginning Month Cash Balance + Total Cash Receipts – Total Cash Payments. 

Simply put, a negative cash balance will require an increase in cash receipts, a decrease in payments, or accessing a short-term loan.  The second bottom-line is the End of Month Available Cash, which is calculated by subtracting the Monthly Contingency Cash Desired and Short-term Loans required. 

The third bottom-line is the Cash Required for Capital Investments, which is calculated by taking the End of Month Available Cash and factoring in Desired Capital Cash and Long-Term Loans Required. 

By effectively Planning your Cash Flow Forecast and Managing the various key elements of the Cash Flow Budget, a business owner can determine the right amount of cash available, when needed.  Please refer to the end of this blog post for a Cash Flow Budget Worksheet to assist you in Forecasting, Planning and Managing your Company’s Cash Flow. 

Resource:  Please refer to the ABC Business Plan Guide and Workbook for information on developing the Cash Flow Statement and Company Budgets, along with detailed financial analysis and formulas. 

Having constructed your Cash Flow Budget, you can now effectively manage your Cash Flow needs.  By using some numbers from your Income Statement and Balance Sheet, you can analyze your present cash situation and apply that to future Cash Flow analysis.  It is important to understand the relationships between your Financial Statements in order to effectively Manage, Plan and Forecast Cash Flows. 

A couple key formulas will help you predict and manage sales related Cash Flow issues¹:

1)     The Average number of days to collect money from customers or the Days Sales Outstanding (DSO):

(Accounts Receivable divided by Annual Sales) x 365

2)     The Average number of days to pay your bills or Days Payables Outstanding (DPO):

(Accounts Payable divided by Annual Sales) x 365

So how can the DSO and DPO be applied to your business situation?

1)     If your DPO is greater than your DSO, you can carry or float your bills longer than your customers do and cash will accumulate.

2)     If DSO is greater than DPO and your customers are slower in paying their bills, then cash is departing the business.

3)     When DPO is greater than DSO, the bigger the difference, the more cash is flowing into the business and vice versa.

4)     The difference between DPO and DSO, termed the Float, is the number of sales days in cash that is flowing in or out of the business each year.  The equation is:  (Sales divided by 365) x Float

a)     As an example: A $1.5M  Sales Revenue business with only eight days of negative float will see $33,000 in cash flow go out the door.  This problem can be compounded if the drop happens during one payment cycle.

So how can you fix negative cash flow? 

Well, it is really pretty simple.  A couple options:

1)     Collect receivables more quickly from customers.

2)     Obtain better payment terms from suppliers.

Combining options one and two will exponentially increase your cash flows, putting much less strain on your business operations and allowing you to manage more effectively for Profits. 

Resource:  For more information on Profit Fundamentals, Analysis, Planning and Application, please see our article on Maximizing Profits in your Business. Also, consider online MBA programs to enrich your knowledge of cash flow in businesses.

Conclusion

In order to effectively manage Cash Flow in your business, you must understand the relationship between your Cash Flow Statement, Income Statement and Balance Sheet, and what these financials are telling you.  The Cash Flow Budget is the first step in developing your Cash Flow Statement, utilizing the numbers generated through your Profit Analysis and Income Statement and your Balance Sheet. The Cash Flow Budget is a great tool to manage and plan your levels of Cash Flow (please see an example Cash Flow Budget Worksheet below). 

Footnote 1: Entrepreneur Magazine, January 2009, “Keeping Tabs on Cash Flow” by David Worrell. 

Monthly Cash Flow Budget Worksheet Example

[ Monthly Basis; Budgeted and Actual Columns ]

Expected Cash Receipts:

1.     Cash Sales

2.     Accounts Receivable Collections

3.     Other Income

4.     Total Cash Receipts

Expected Cash Payments:

5.     Purchase Goods & Equipment

6.     Salaries

7.     Utilities

8.     Depreciation

9.     Rent

10.  Building Services

11.  Insurance

12.  Office Expenses

13.  Interest

14.  Sales Promotion

15.  Taxes & Licenses

16.  Maintenance

17.  Delivery

18.  Misc

19.  Total Cash Payments

Cash Balance:

20.  Beginning Month Cash Balance

21.  Cash Change (item #4 minus #19)

22.  End of Month Cash Balance

23.  Desired Contingency Cash Balance

24.  Short-Term Loans Required

25.  Available Cash- End of Month

Cash for Capital Investments:

26.  Available Cash- End of Month (line #25)

27.  Desired Capital Cash

28.  Long-Term Loans Required

Disclaimer: ABC Business Consulting and the Blog Author do not endorse any products mentioned in this blog post. It is for informational purposes only.

Posted in Business Financials. Comment

The Overlooked Financial – The Balance Sheet

April 21, 2010 by Frank Goley, Business Consultant

Often, businesses concentrate on their Income Statement and Cash Flow Statement without much consideration to the Balance Sheet.  This is a mistake!  The Balance sheet is important because it:

Ø  Shows the effect of past decisions

Ø  Keeps track of a company’s cash position liquidity

Ø  Records what the Owner’s Equity position is at different time intervals

Ø  Directly affected by the Cash Flow and Income Statements, which reflect the status of the company’s operation

Ø  Quickly shows the Condition of a Business

The Balance Sheet illustrates how a Company’s Assets, Liabilities and Net Worth are distributed at a given point of time or time period.  The Balance Sheet set format facilitates analysis.  The order of the Balance Sheet’s itemized categories is arranged in the order of Decreasing Liquidity and Immediacy for Assets and Liabilities respectively.  Because the Balance Sheet shows changes in Debt, Net Worth and the Company’s condition over time, it is an excellent tracking and control document.  Before getting into Balance Sheet Analysis, let’s examine the important sections of the Balance Sheet (please find a Balance Sheet (simple format) as an Appendix at the end of this article).

Ø  Current Assets:  Cash, Government and Marketable Securities, Notes Receivable, Accounts Receivable, Inventories and Prepaid Expenses.  Any other item that can be converted to Cash within one year.

Ø  Fixed Assets:  Land, Plant, Equipment, Leasehold Improvements.  Other items that are expected to have a useful business life which can be measured in years.

ü  Depreciation applied to items that wear out.

Ø  Other Assets:  Intangibles such as Copyrights, Patents, Contract Exclusivity and Notes Receivable from Company Employees and Officers.

Ø  Current Liabilities:  Accounts and Notes Payable; Expenses that Accrue (such as Wages, Salaries, Withholding, FICA); Taxes Payable; Current part of Long Term Debt; and other Obligations coming due within a year.

Ø  Long Term Liabilities:  Trust Deeds, Mortgages, Equipment Loans and Long Term Bank Loans.  All of these are Net of the current part of Long Term Debt (appears as a Current Liability).

Ø  Net Worth:  Assets minus Liabilities.

Ø  Owners Equity:  Principals Equity Stake, Retained Earnings and other Equity.

Balance Sheet Analysis

Three ways to quickly determine the health of your business:

1)     Analyze Working Capital:  Subtract Current Liabilities from Current Assets to determine your Working Capital level.  Cash is only part of Working Capital.

a)     Illiquid Businesses can have a hard time securing future loans.  Solutions are Working Capital Loans, Fixed Asset Sale, Financing Accounts Payable or Securing New Equity Investment.

Resource:  For comprehensive information on Business Finance and Funding, please refer to the ABC Business Consulting Business Finance Section in its Business Success Articles.

2)     Compare Fixed Period Balance Sheets:  By comparing similar periods of time, you can quickly spot Trends and Weak Areas, which upon investigation, you can determine the reasons driving them.  If you are an established Company, compare yearend Balance Sheets.  If a new company, compare Balance Sheets from one quarter to the next.  Upon analysis, problem areas and strong areas jump right off the paper!

3)     Current and Acid Test Ratios:  These analyses are percentage verses dollars based so it is easy to compare against industry and area norms of similar companies.

a)     Current Ratio:  Measures a Company’s Liquidity or its ability to meet current obligations in the next year.                             

i.        Formula:  Current Assets ÷ Current Liabilities                            

 ii.        In order for the analysis to mean anything it is important to understand what is represented by this ratio.  Factors affecting the Current Ratio are Type of Inventory, Quality of Receivables, Sales Cycle Timing, Time of Year, etc.  A ratio of 2.0 typically represents a healthy company but it really dependent on the type of company and industry.

b)    Acid Test:  The “Quick Ratio” is calculated by dividing a Company’s Most Liquid Assets by Current Liabilities.  Liquid Assets include Cash, Securities and Current Accounts Receivable.  A ratio of 1.0 typically represents a healthy company but is company and industry specific.

Note:  A 2.0 Current Ratio and 1.0 Acid Test (Quick Ratio) benchmarks are non-industry specific.  Be sure to investigate the healthy levels for companies closely resembling yours.  Trade Associations, Banks and Dun & Bradstreet are good sources of ratio comparative information. 

Footnotes:  Footnotes of assumptions and calculations are very important for a 3^rd Party reader, such as a Banker.  A Bank would be interested in how restricted your Assets are, so an explanation for each Asset item would be in order.  An investor would be very interested in the details of Owners Equity.  A Banker would also be interested in a breakdown of Accounts Payable, detailing exactly when liabilities come due.

Resource:  For extensive information on Balance sheets and details on Financial Ratios, please refer to the ABC Business Consulting Book:  The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning. 

Example Balance Sheet (Simple Format) 

Assets Current AssetsFixed Assets

·         (Less) Accumulated Depreciation

·         Net Fixed AssetsOther Assets

TOTAL Assets

Liabilities

Current Liabilities

Long-Term Liabilities

TOTAL Liabilities  

NET Worth / Owners Equity

Total Liabilities & Net Worth  

See the ABC Business Planning Guide for more detailed information on Balance Sheet and Financial Formats.

Posted in Business Financials. Comment

Breakeven Analysis – The Importance of Knowing Your Company’s Breakeven Point

April 20, 2010 by Frank Goley, Business Consultant

We all know that the Breakeven Point in a business is when it’s not making a profit or losing money.  Sounds simple, right?  Well, can you tell me what your exact Breakeven Point is?  Probably not.  Most business owners either don’t know it or think they know it, with neither exactly knowing.  Breakeven can be expressed as a Dollar amount or Unit Sales, and once determined, you have a Target to reach through a carefully thought out Business Plan.  Without an established Breakeven Target, your Strategic Plan is floundering.

It is very important to understand that increased Sales do not always translate into increased Profits.  Many companies have gone out of business by ignoring the importance of Breakeven Analysis, thinking increased Sales will lead to certain Profitability.  Unfortunately, more often than not, the company’s Variable Costs, or those directly derived from sales levels, get exponentially larger as Sales Volume Grows.  Not knowing the Variable Costs is a silent killer for many companies.

When calculating the Breakeven Point, you will have to make certain assumptions and estimates.  Error on the side of conservative numbers by using more pessimistic sales and margin thresholds, while overstating your projected costs.  You want the Breakeven Point to be in the safe zone – a worst case threshold. I will present some Breakeven formulas which err on the simple side, you can get very complicated with different Breakeven Formula variations. The point I am making here is providing some simple formulas you can quickly calculate your Breakeven and understand where you are presently and what it looks like projected. Once you have a handle on that, then maybe more sophisticated Breakeven Analysis is warranted and advantageous. Keep it simple to start.

Breakeven Formula:  S = FC + VC

S = Breakeven point of sales in dollars

FC = Fixed Costs in dollars

VC= Variable Costs in dollars

Fixed Costs:  Costs that remain mostly constant despite what the Sales Volume may be.  Fixed Costs remain constant in a certain range, after which they change, particularly, after a steep increase in Sales (i.e.  you need a bigger building or more employees).  It is important to understand that these costs must be paid no matter whether the company makes sales or not. 

Fixed Costs include:

Ø  Overhead Costs:  Rent, Office / Administrative Costs, Salaries, Benefits, FICA and so forth.

Ø  Interest Charges:  For Term Loans and Mortgages.

Ø  Hidden Costs:  Depreciation, Amortization and Interest.

Variable Costs:  Costs directly associated with the Sales level and include:

Ø  Costs of Goods Sold

Ø  Variable Labor Costs

Ø  Sales Commissions

When you don’t know what your Variable Costs will be, you can use a variation on the Breakeven Formula, provided you know what your Gross Margin will be as a percent of Sales:

S = FC ÷ [1- (Variable Expenses*) ÷ Sales]

*:  VE include Material Costs, Variable Operating Expenses and Variable Labor.

To get Breakeven in Units Sold, divide the Breakeven Dollar Amount by the Unit Price.

Why is the Breakeven Analysis Important?

ü  You can plan ahead and determine the amount of finance needed to grow the company.

ü  By graphing the Breakeven Analysis pictorially, it is much easier to make the Strategic Objectives more tangible and achievable.

ü  You can use the Breakeven Formula to measure your Company’s progress toward Profit Goals.  It is a great tracking tool when graphed pictorially and can work in conjunction with your Strategic Plan’s Milestone Goals.

ü  Understanding what your Breakeven Point is when setting Profit Goals through the formula:S = FC ÷ [1- ((Cost of Sales + Variable Operating Expenses) ÷ Sales)]

ü  Breakeven Charts help your employees visualize your Company’s progress toward profit goals.

ü  Once you know your Breakeven Sales level, then you can break that Sales Level down into the amount of Customers required.

ü  Plug in three Sales Values (Best, Worst Case and Most Probable) to determine when your Fixed Costs will be covered.  This is invaluable when planning your Finance Requirements.

ü  Breakeven Analysis is an excellent process to determine the effect of different unit costs for expected sales for each unit type.  Understanding which your most profitable units are, and how they relate to Breakeven and Profit Goals is the heart of your Marketing Strategy and Strategic and Sales Plan.

If Breakeven Analysis is used as a tool to realistically understand Profit Projections and Profit Analysis, it is extremely effective.  A Business Owner and his/her Employees knowing on a daily basis what it takes to breakeven for the month, quarter or the applicable period of time, is a powerful tool in realizing a Company’s Profit Goals.  Moreover, Breakeven Analysis is directly affected by a Company’s Marketing Plan and vice versa.  The Company Strategic & Sales Plan is a realization of the breakeven Analysis.  When you think of it this way, Breakeven Analysis is at the core of planning and analysis necessary for Business Success.  It is a great tool, only if you use it!

Be sure to check out my other Financial Management Articles for more profitability tips and strategies.

My Business Planning Book contains numerous Financial Formulas and Ratios which can be very helpful in your Breakeven Analysis and Planning.

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Financial Data Analysis and Management – Its Importance for a Successful Business

April 19, 2010 by Frank Goley, Business Consultant

Planning and Control are the two most important ingredients to a Successful Business.  A Business Plan takes most of the guess work out of Business Strategy and Control through solid Financial analysis. Financial Data provides a  way to gauge where you are in your Strategic Plan, telling you where changes in your Plan are necessary.  Because of this, Financial Data Analysis and Management are vitally important to running a successful business.

It is extremely important to have a suitable Accounting System installed throughout your business so data acquisition is easy.  You cannot manage your Business for Profitability without a good Accounting System.  My CPA has a bookkeeper who comes out to the business to help install the Accounting System and show us how to work it.  All of this is done with the guidance of the CPA but at a fraction of the cost.  A good Bookkeeper is invaluable in helping capture Financial Data. Having an established working Accounting System in place will minimize the fees a CPA charges to analyze your tax liability and prepare your tax returns.

An Accounting System is typically built around the following key Financial Management tools:

ü  Income Statement (Profit & Loss Statement)

ü  Cash Flow Statement

ü  Balance Sheet

ü  Budget

ü  Breakeven Analysis

By having a Financial Management system in place, you can easily identify early warning signs or spot particularly profitable areas.  Not having a system in place to analyze and organize Financial Data makes it impossible to effectively manage, grow and control a business.  It makes it impossible to gauge the success (or lack there-of) of your Planning and Strategy.  Moreover, used incorrectly, inaccurate Financial Data can be disastrous for a company’s livelihood. 

An Accounting and Financial Management System is only as useful as it is used systematically throughout an entire business.  It is extremely important to implement the system into the very fabric of the business and be used systematically.  The Accounting System is a reflection of the health, or lack thereof, of a business and from which business decisions are made.  Make sure to set it up right, train your people on it and most importantly, use it!

Two principal objectives of any business are to be Profitable and have Cash Flow to pay obligations.  The Income Statement and Cash Flow Statement figure prominently in this area.  The Income Statement represents how well a Company is operating, and the Cash Flow Statement shows how well a business is managing its Cash.  Profit or Loss on one side and Liquidity on the other.

The key is to find a good balance between Profits and Liquidity, which when not well planned for, can be very difficult to maintain.  Fast Growth with high profits can drain the liquidity of a business, so being Profitable is no guarantee you’ll stay in business.  The role of the existing and projected Cash Flow and Income Statement is to help you identify problems areas so you can effectively plan for them, such as raising more capital, infusing more equity or obtaining finance.  Moreover these two statements help you identify areas which can be better controlled and managed, forestalling the need of additional capital and funding.

Resource:  Be sure to read my articles on Cash Flow Management and Profit Analysis for extensive help in these areas. 

The Breakeven Analysis is based on the Cash Flow and Profit & Loss Statement.  The Breakeven Statement and Chart is extremely important because it shows the revenue volume from sales that are required to precisely balance the sum of your fixed and variable expenses.  The Breakeven Analysis can be extremely helpful when:

ü  Setting Product and Service Price Levels

ü  Deciding whether to purchase or lease equipment / building

ü  Figuring out profit projections based on various sales levels

ü  Determining if new employees are required

ü  Planning ahead for finance / capital required in the future

ü  Making Strategic Objectives more tangible and achievable

ü  Measuring your Company’s progress toward Profit goals

Resource:  For more information on Breakeven Analysis, please see my article:  The Breakeven Analysis- The Importance of Knowing your Company’s Breakeven Point. 

The Balance Sheet records the past effects of company decisions (or lack thereof) and projects the affect of future Plans.  The Balance Sheet is a record of the company’s Liquidity and Owner’s Equity.  These variables are directly affected by the Income and Cash Flow statements.  The Balance Sheet is the often overlooked Financial but it has a lot of utility:

ü  Shows the effect of past decisions

ü  Keeps track of a  Company Cash Liquidity Position

ü  Records the level of Owner’s Equity

ü  Quickly shows the condition of the business

Resource:  For more information please see my Article on The Balance Sheet – The Overlooked Financial.

A Budget Analysis compares a Company’s Actual Performance to Projected Performance on a monthly, quarterly and annual basis.  The Budget is a great tool to guard against excessive, unmitigated expenses and is closely tied to the Strategic Objectives the company has set.  Analyzing the Income Statement and Cash Flow Statement projections against Actual Performance is an excellent control tool, which can quickly address problems before they become too severe.  Little oversights and mistakes in a Company’s Projections spread over time can have a disastrous affect.  The Budget Analysis is your guard against that.

Resource:  Please see my article on Cash Flow Management for detailed explanation on Budget Analysis.

Working together, the Income Statement, Cash Flow Statement, Balance Sheet, Breakeven Analysis and Budget Analysis provide a complete picture of a company’s Current Operations, Liquidity, Past Operations and Future Viability.  Working through an interactive Accounting System can be a very useful tool in determining future business scenarios and analyzing past mistakes.  Understanding the financial implications of your Financial Decisions can mean the difference between your company’s success and failure.  Probably the most important financial is your Cash Flow Statement but understanding all of these financials and how they work together is the key to a company’s success.  Projections are based on assumptions – make sure these are well thought out and as realistic as possible.

Resource:  For more information on Financial Formats, Analysis, Formulas and Projections please consult the ABC Business Planning Book:  The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning.

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